7 Ratios to Teach Your Clients

Maria Tanski-Phillips
Posted by Maria Tanski-Phillips on Aug 27, 2021 11:12:51 AM

As a tax professional and your clients’ trusted advisor, you want to see your clients succeed. To help them and their businesses thrive, you can teach them how to use their cloud accounting software to analyze finances and calculate ratios. Remember, you're their trusted advisor. And although these are simple enough to understand for you, your client may need some coaching.

Ratios in cloud accounting

Cloud accounting can obviously work wonders for your clients. Not only can it help you and your client keep their books in order, but it can also help your client get a better grasp on their finances by looking at reports, totals and ratios. So, which ratios should you make sure your clients understand how to calculate?

1. Debt-to-equity ratio

One ratio your clients should understand is the debt-to-equity ratio. A debt-to-equity ratio is the relationship between your client’s debt and equity. It can tell your client how high their debt is in comparison to their equity and if they can take on more debt.

To calculate debt-to-equity, your client needs to understand and use the following formulas:

Equity = Assets – Liabilities

Total Debt = Long Term Debt + Short Term Debt + Fixed Payments

So, where can your clients find the totals to plug into the above formulas? To find equity and total debt, let clients know that they can use their balance sheet. Once they calculate their total debt and equity, they can find their business’s debt-to-equity ratio by dividing total debt by total equity.

Debt-to-Equity Ratio = Total Debt / Total Equity

Your client’s ratio tells them how much debt they have for each dollar of equity.

Let your clients know that a “good” ratio can vary depending on the goods and/or services they offer and their industry. And, be sure to meet with them if they have questions about improving their debt-to-equity ratio.

2. Debt ratio

Chances are, your clients have some form of debt. But, taking on debt isn’t always a bad thing. A client can use a debt ratio to determine whether or not they’re taking on too many liabilities.

To get the financial data for the debt ratio, clients can look at their balance sheet and use this formula:

Debt Ratio = Total Liabilities / Total Assets

Make sure your clients understand that the debt ratio can tell them whether they have more debts than assets and how they compare. If a client has a high debt ratio for their business or industry, you can help them come up with a game plan to start paying off some of their debts.

3. Profit margin

If your client wants to know how much revenue they keep after paying expenses, they can find their profit margin. Your clients hire you to help them make sense of their data. So, make sure your clients understand the formula to calculate their profit margin.

Clients can use their cloud accounting reports to find their total revenue and expenses. Then, they can use following formula to calculate their profit margin:

Profit Margin = (Revenue - Expenses) / Revenue

Let clients know that standard profit margins can vary from industry to industry. If the client has a low profit margin, they can consider increasing prices, upselling and cross-selling, and selling old inventory.

4. Gross profit margin

Gross profit margin works similarly to profit margin, but it measures the income left over after accounting for cost of goods sold (COGS).

To calculate their gross profit margin, clients can use their income statement (COGS and revenue). Here’s the formula clients can use:

Gross Profit Margin = (Total Revenue – COGS) / Total Revenue

A client can use gross profit margin to determine the profit margin of a single service or product and be able to see which items are most and least profitable. Like with profit margin, clients can use their gross profit margin to adjust prices.

If clients have questions about what gross profit margin and how it differs from profit margin, go over the answers with your clients to clear up any confusion.

5. Current ratio

Clients can look at their current ratio to see how strong they are financially. The current ratio, or working capital ratio, uses asset and liability totals to check if the client’s company will be able to pay its debts due in the next 12 months.

Like with many other ratios, clients can pull a balance sheet report to get totals to plug into the formula:

Current Ratio = Current Assets / Current Liabilities

Ensure clients understand the current ratio by giving them a rundown. Let them know they can use their current ratio to assess their short-term liquidity and determine if revenue is being properly invested.

6. Quick ratio

A quick ratio can help your clients evaluate their ability to meet financial obligations. Let your clients know they can calculate this ratio quickly (pun intended) by grabbing data from their balance sheet.

To find their company’s quick ratio, your clients can use this calculation:

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

Let your client know how they can find their quick ratio using their cloud accounting reports. A healthy ratio is 1 or more. If your client has a ratio less than 1, work with your client to help them increase their ratio so that they have more assets than liabilities.

7. Return on investment

Another ratio your clients should understand and learn how to calculate is return on investment, or ROI. ROI shows the money your client invests and how much they’re getting back from said investment.

Inform your clients about the importance of ROI and how they can use it to see if an investment has paid off. Give them the following formula and let clients know they can pull numbers from their financial statements (e.g., balance sheet):

ROI = (Earnings – Initial Cost of Investment) / Initial Cost of Investment

Your client can find revenue, cost of goods sold, and operating expenses on their company income statement. The higher the ratio, the better.

Work with your clients to help them understand and improve their ROI, if needed. You can guide them by finding where they can decrease expenses and helping them make smart financial decisions.

Topics: Cloud Accounting


 

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